The dangerous game of short selling that exposes investors to potential unlimited losses

Here in America, we like to rally behind the underdog. We love Rocky Balboa, the famous quote from Notre Dame coach Knute Rockne, “Win one for the Gipper”, and of course the ode to the bedrock of the American dream, the immigrants who made this great country, in the New Collossus:

“Give me your tired, your poor,
Your huddled masses yearning to breathe free,
The wretched refuse of your teeming shore.
Send these, the homeless, tempest-tost to me,
I lift my lamp beside the golden door!”

Well, when it comes to the little companies trying to slug it out in the small and micro-cap markets, there is no such dedication to support and cheer them on. In fact, it is quite the opposite. By definition, shorting, or short-selling, is when an investor borrows shares and immediately sells them, hoping he or she can scoop them up later at a lower price then return them to the lender and pocket the difference. Shorting is much riskier than buying stocks, or what’s known as taking a long position.

MarketWatch recently stated in the article, Why You Should Never Short-Sell Stocks, that while famous investors do it, but the average investor has too much to lose. So even with all the risk, why do investors, and rumor has it, the trading desks within most brokerages, still do it? Well in that same article is a quote that should send chills up the spine of any amateur shorter. Referring to Joe Campbell who infamously lost the farm when he placed a $37,000 short position on KaloBios Pharmaceuticals Inc. (the stock went up 800% and Campbell’s broker was not fast enough to get out) in November 2015, George Schultze, founder and CIO of Schultze Asset Management in Purchase, N.Y., said “it is that kind of uninformed investor that makes a market opportunity for all of us professional investors, not only on the short side, but on the long side.”

See what most uninformed “shorters” don’t know, if you have a short position, there’s no limit to how much money you can lose if the shares rise. If the share price increases soon after you place a short position, you could quickly “cover” by buying back the shares and returning them to the investor you borrowed them from. If you’re lucky, you might not lose very much.

To level the playing field, short sellers use a tactic called bashing to help them bet against companies making their way up the ranks. Progressive Care, Inc. (OTC QB: RXMD) is a young company with growing revenues, recent up listing from the Pink Sheets to the OTC QB making them a reporting company to the SEC, has fallen prey to this tactic. As absurd as these bashes may be, they do have a dramatic affect on the uninformed shareholder. For instance, give these a look;

Was there an SEC investigation? No one inside the company is aware of one. Does Jim Cramer ever cover penny stocks, not that he is aware of. So unfounded and ludicrous accusations, also known as slander, is common place on stock message boards like the one above at Yahoo Finance. These message boards plague small companies and small investors alike. Like any scam, they use false information playing on the fears of investors that took a chance on a rising company like Progressive Care.

Investors have to show some common sense when presented with flat out lies. Bashers love to say that management is selling all of their shares. Well then what about the leak out rules that seek to curb such behavior? I am sure there have been more than a few bad CEOs that have created a plan to get around the SEC, FBI, and other powerful agencies, but level heads have to admit it is a scary proposition to try to scam the likes of the IRS and SEC all at once. Still, shareholders on message boards eat that nonsense up. Investopedia has this to say about this practice, “Short and distort” is an illegal tactic used by unscrupulous short sellers wherein they short a stock and then spread rumors and innuendo to drive down its price. A bear raid refers to short sellers who connive to push a stock lower through concerted short selling and rumors of negative developments.

So, what are regulators doing about all of this and will it help? In January 2005, the SEC implemented Regulation SHO, which updated short sale regulations that had been essentially unchanged since 1938. Regulation SHO specifically sought to curb the practice of “naked” short selling, which had been rampant. Then, In February 2010, the SEC adopted an “alternative uptick rule” – also known as Rule 201 – that restricts short selling by triggering a circuit breaker when a stock has dropped at least 10% in one day. The SEC said this would enable sellers of long positions to stand “in the front of the line” and sell their shares before any short sellers once the circuit breaker is triggered. With U.S. and global equities recovering from a severe bear market at the time, the SEC also said that the rule was intended to promote market stability and preserve investor confidence.

So, is it working? Is the work of regulators curbing the practice of short and distort? It is hard to see it if it is. Consequently, what can investors and small companies do to protect themselves? When it comes to the investors, they have to arm themselves with information straight from the company via their filings with the SEC and their press releases. Furthermore, investors have to slow to be judgement and gather real facts not bad innuendos and rumors. Companies must make every effort to respond in a timely manner via shareholder calls, press releases, social media to baseless accusations thereby keeping their valuable investors informed and pacified. A reality check is also a must for both sides. Companies have run their business and not be a public relations company in crisis control. Investors need to pump the brakes and ask common sense questions. Don’t be duped by fear mongers trying to make a buck off your gullibility.

It is clear that selling short is here to stay, but possibly tactics like short and distort are on their way out. To keep the American Dream alive for young companies and novice investors alike, a laser focus by regulators on lascivious tactics like short and distort is crucial.

About the Author

Stuart Smith is the CEO and Founder of SmallCapVoice.com. SmallCapVoice.com. is a recognized corporate investor relations firm, with clients nationwide, known for its ability to help emerging growth companies build a following among retail and institutional investors. SmallCapVoice.com utilizes its stock newsletter to feature its daily stock picks, audio interviews, as well as its clients’ financial news releases. SmallCapVoice.com also offers individual investors all the tools they need to make informed decisions about the stocks they are interested in. Tools like stock charts, stock alerts, and Company Information Sheets can assist with investing in stocks that are traded on the OTC BB and Pink Sheets. To learn more about SmallCapVoice.com and their services, please visit https://smallcapvoice.com/blog/the-small-cap-daily-small-cap-newsletter/